Monday, January 18, 2016

Is The Bloodbath in Stocks Over?

The stock market’s bloodbath Friday was not the final flush needed to clear the way for a recovery, according to a widely-watched indicator of selling intensity.

Many technicians, as well as old-school fundamental investors like Warren Buffett, say that the time to start buying in a falling market is after signs of panic, or capitulation by the bulls.

But after the Dow Jones Industrial Average plunged 391 points, or 2.4% on Friday--the biggest one-day percentage decline in 3 1/2 months--the New York Stock Exchange’s Arms Index suggested bulls were anxious, but not quite scared enough to throw in the towel.

The Arms Index is a volume-weighted measure of market breadth, which is calculated by dividing the ratio of the number of advancing stocks to declining stocks by the ratio of advancing volume to declining volume. When the market is declining, the Arms Index usually rises, as the volume in declining stocks tends to increase faster than the number of stocks that are declining.

In other words, sellers tend to hit the sell button a little harder when the market is falling, then when it isn’t.

An Arms reading of 1.0 implies buying and selling is in complete balance. Technicians see a rise to the 2.0-to-3.0 range as the threshold to imply panic, or capitulation.

On Friday, the NYSE’s Arms rose to just 1.791.In comparison, last year’s high for the NYSE Arms was 4.95 on Sept. 1, when the Dow plunged 470 points. The Dow rose 293 points the next day, and ran up 1,830 points over the next three months.

Meanwhile, when the Dow tumbled 392 points last Thursday, and the NYSE Arms rose to just 1.28, the Dow slumped another 168 points the next day.

Wow, scary stuff, right? But before you get all up in arms over the "Arms Index" and throw in the towel on stocks, let's examine another point of view and dig a little deeper.

Few investors want to lash themselves to the mast of the ship in a storm such as the one we’re in right now. The S&P 500 index has fallen about 8% so far in 2016, and there could be more misery where that came from. The selloff has more to do with weakness in the Chinese economy and other overseas markets than with problems here at home. And China’s economic and market woes seem likely to get worse before they get better.

Yet fortunes are made in times like these, which a simple glance at a stock chart can reveal. During a similar selloff last August and September, stocks fell by 11% during one eight-day period (Aug. 17 – 25) and then by 6% during a 12-day swoon at the end of September. If you were shrewd (and lucky) enough to have bought at the low point on Aug. 25, you would have been up 13% by early November—a pretty heady gain for a mere two and a half months.

Here’s a one-year chart of the S&P 500, clearly showing the drop-offs and rebounds:

Trying to time the market is a fool’s game, of course, and virtually nobody calls bottoms and tops with any consistency. There’s a broader point, however: Relatively strong fundamentals in the U.S. economy tend to counterbalance weakness elsewhere, even if the volatility can be nauseating. “I would remind you not to get overly pessimistic, no matter how badly the price action may look during any given day, week or month,” financial advisor Josh Brown wrote recently on his blog. “Remember that the woes of today lead to the gains of tomorrow.”

Will there be gains tomorrow? Or any time soon? If you believe the data on the U.S. economy, the answer is probably yes. To quickly review a few things that are going right: Employers are creating more than 200,000 new jobs each month, on average, which has pushed the unemployment rate down to 5%. Car sales are booming, which means consumers have money and are confident about committing to long-term purchases. The early returns on fourth-quarter corporate earnings have been positive, with banks such as J.P. Morgan (JPM), Citigroup (C) and Wells Fargo (WFC) beating expectations.

There are plenty of weak spots in the data, too, giving doomsayers a toehold in reality. Still, there are few signs, if any, that a U.S. recession is coming. Citigroup, for instance, pegs the odds of a recession at a mere 18% during the next 12 months. Wall Street analysts in general are still calling for gains in the S&P 500 stock index of 5% to 15% by the end of 2016.

They could be wrong, needless to say, but the Wall Street consensus has been dead right on one important prediction: Expect more volatility. That defined markets in the second half of 2015, and it’s how 2016 began (see the chart above). With China unpredictable and far from transparent, there’s no reason to expect the wild ride to calm down anytime soon. But investors should remember that volatility includes upswings as well as downswings.

I don't agree with everything in Rick Newman's comment but he's right, expect more volatility in 2016 and pick your spots when buying the big dips. On that last point, market participants need to do a better job reading and understanding volatility, especially in this environment.

Interestingly, I was trading and paying close attention to various stocks on Friday, two of which I discussed last Thursday in my comment on the brutally cold chill of deflation, going over why you shouldn't follow RBS's advice to sell everything just yet.

First, let's look at a sample of stocks I track on those betting on a global recovery (click on image):

You will notice that Friday's sell-off hit commodity, energy and metal and mining shares very hard. But I was paying attention to shares of Freeport-McMoRan (FCX), a copper miner and leveraged play on global growth, and they ended up green, which was somewhat positive given what an ugly day it was (still, this stock is technically damaged, and only experienced traders should trade it here).

Next, I was checking out shares of Bill Miller's favorite biotech, Intrexon (XON) which have rallied sharply since Thursday morning (click on image):

Now, this stock is also technically damaged but it was also way oversold and for a biotech with a bright future, it was due for a major bounce. Was it just short-covering, conviction buying or both, I don't know, but the point is these markets can turn on a dime and always look at micro data and the response of individual stocks before making big proclamations on the entire stock market.

Importantly, while I'm definitely worried about a looming deflation tsunami, especially if an emerging markets crisis hits us this year, I'm also keenly aware that central banks stand ready to save the word and they will do whatever it takes to shore up confidence if markets continue to slide lower.

Having said this, I continue to steer clear of Chinese (FXI), emerging markets (EEM), energy (XLE), Metals and Mining (XME), Oil & Gas Exploration (XOP) and commodities (GSG) in general because downside risks remain too high and it could take a very long time for these sectors to come back. But stocks don't go down in a straight line and there will be tradable rallies in these and other sectors that got killed early this year. Experienced traders will make a fortune buying the dips and selling the rips in 2016. Let me show you where I see opportunities going forward in a few charts.TechnologyApple's (AAPL) sliding shares have hit tech stocks hard but Technology (QQQ) is more diverse than Apple and its chart tells me this is a great dip to buy here (click on image):

Biotech shares and Healthcare

Small (XBI) and large (IBB) biotech shares have been hammered early in 2016, but I haven't changed my mind on this sector since I recommended loading up on it in late August. In fact, I used the latest sell-off to add to my positions and will keep adding to my positions if stocks slide lower. I know most traders are avoiding small and large biotech shares in these uncertain markets but in my humble opinion, this is where the big opportunities lie ahead once these jittery RISK OFF markets calm down (click on images):

If biotech shares make you nervous, focus your attention on healthcare (XLV), which contains big pharmaceuticals as its top holdings and other healthcare stocks, including healthcare insurers and some big biotech companies (click on image):

Financials

As I explained in my Outlook 2016, I'm not too gung-ho on Financials (XLF) in a deflationary environment, but even here the recent sell-off presents interesting opportunities. Also, keep an eye on financial stocks as the Fed won't dare raise rates if bank stocks keep sliding.

Utilities & REITs

As shown below, Utilities (XLU) have held up relatively well during the latest sell-off (click on image):

The reason is simple, utilities are interest rate sensitive and rates keep declining in a deflationary environment. Also, with deflation, you need pricing power, which utilities have.

Still, be careful, if markets go back to RISK ON mode, you will see Utilities rolling over here as rates start rising. In fact, have a look at REITs (VNQ) which have already rolled over in anticipation of rising rates (click on image):

Real estate makes me nervous for all sorts reasons, the least of which is rising rates. The rising risk of global deflation doesn't augur well for the real estate sector, especially in prime markets like London and New York City.

This concludes my short whirlwind tour of various stock sectors. I see too many people nervous out there. RELAX or as they say in Jamaica, CHILLAX!! Stocks don't go up and down in a straight line and there's no imminent crash on its way, at least not yet.

As I stated in my Outlook 2016, deflationary headwinds are picking up and we are experiencing their brutally cold chilling effects on markets, but don't start throwing the baby out with the bathwater just yet. This will be another year where those that know when to buy the big dips and sell the big rips will come out ahead.

On that note, it's been a roller coaster ride for U.S. markets this past week, but the dip could soon end and investors should 'stay put', said Jurrien Timmer, director of global macro at Fidelity Investments, in a CNBC interview.

Timmer thinks opportunities lie specifically "not necessarily in the overall S&P 500, but in those really beaten down areas like emerging markets, equities, commodities, high-yield credit." I don't agree with him there except for a tradable rally but listen to his comments on China and the Fed's policy below.

Lastly, widely followed market watcher Dennis Gartman cautioned on Tuesday that any bounce in stocks will be short-lived, stating he's concerned about the decline in money supply as measured by the St. Louis Fed's adjusted monetary base. I think he's wrong focusing only on the Fed and not global central banks which in aggregate are pumping extraordinary liquidity into global markets.

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